Idle production: use normal capacity before costing each unit
A factory incurs £120,000 of fixed production overhead but makes only 6,000 units against normal capacity of 10,000. Allocating all £120,000 at £20 per unit would put too much cost into stock. Under IAS 2, the normal-capacity rate is £12 for these facts, leaving £48,000 of unallocated overhead as current expense.
Choose a capacity measure that reflects normal operation
IAS 2 paragraphs 12 and 13 include a systematic allocation of qualifying fixed and variable production overhead in conversion cost. Fixed factory depreciation and factory management can qualify. The fixed-overhead allocation uses normal production capacity, rather than automatically dividing this period's overhead by this period's output.
Normal capacity means production expected on average over a number of periods or seasons under normal circumstances, allowing for planned maintenance. It is neither the plant's theoretical maximum nor necessarily this month's budget. Actual output may be used when it approximates normal capacity.
This guide applies UK-adopted full IFRS to a 2026 annual period, without early adoption of IFRS 18. The examples concern one homogeneous product and completed units. They isolate fixed overhead, so direct and variable production costs still need their own calculations.
When output is low, paragraph 13 prevents the amount allocated to each unit from increasing just because production fell or the plant was idle. Unallocated fixed overhead is an expense in the period incurred. That expense records unused capacity in the costing model; it is not a measured cash saving.
Sources and context, checked :
Trace the overhead through production and sales
All figures are hypothetical and exclude taxes. Supported normal capacity is 10,000 units after planned maintenance. Actual output is 6,000 complete units and actual qualifying fixed overhead is £120,000. There is no opening stock, abnormal waste or net realisable value shortfall. Of the output, 4,000 units sell and 2,000 remain.
Divide £120,000 by 10,000 normal units to get £12 per unit. Allocate £72,000 to the 6,000 units produced. The remaining £48,000 is unallocated production overhead expense. The sold units carry £48,000 of allocated overhead and closing inventory carries £24,000.
The reconciliation accounts for all £120,000. There is £48,000 in the cost of units sold, £24,000 in stock and £48,000 of unused-capacity expense. These are the fixed-overhead elements only, not the complete cost of the product.
| Fixed-overhead destination | Calculation | Amount |
|---|---|---|
| Units sold | 4,000 × £12 | £48,000 |
| Closing inventory | 2,000 × £12 | £24,000 |
| Unallocated current expense | £120,000 − £72,000 | £48,000 |
| Total actual fixed overhead | Sum of the three amounts | £120,000 |
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Compare the wrong rate and the high-output case
Assume the costs were accumulated in an overhead control account. Record Dr production inventory £72,000; Dr unallocated production overhead expense £48,000; Cr overhead control £120,000. For the fixed-overhead share of the units sold, record Dr cost of sales £48,000; Cr inventory £48,000. Do not duplicate direct or variable cost entries.
Using actual low output as the denominator would give £120,000 / 6,000 = £20 per unit. That would leave £40,000 in the 2,000 unsold units instead of £24,000. Closing inventory and current profit would be £16,000 too high.
Abnormally high output needs care too. In a separate hypothetical case, keep actual fixed overhead at £120,000 but assume production is abnormally high at 12,000 units. Applying £12 would allocate £144,000, more than the cost incurred. For these simple facts, reducing the rate to £10 allocates £120,000. Paragraph 13 requires the lower per-unit allocation so inventory is not measured above cost.
The two cases do not establish a universal rate formula for every factory. Different products and production processes need a systematic allocation that reflects their facts.
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Review the cost pool as well as the denominator
IAS 2 excludes abnormal waste, selling costs and administrative overhead that does not help bring inventory to its location and condition. That does not exclude all administration: qualifying factory management is a production overhead. Review the purpose of each cost before applying the capacity rate.
Keep the approved cost pool, capacity history, maintenance assumptions and actual output with the stock calculation. Reconcile units produced to units sold and on hand. If the business uses standard costs, paragraph 21 requires them to reflect normal conditions and to be reviewed and revised as necessary.
A lasting change in operations may warrant a fresh normal-capacity estimate. One quiet month does not, by itself, justify replacing the existing denominator with the month's lower output. Document the changed circumstances before changing the estimate.